Analysis of the First Plan Year Rule for 401(k) Plans (Posted March 22, 2003) Technical Tip 93: The following question and answer were from the IRS Q&A Session at the 2001 ASPPA Annual Conference: Employer A maintains a profit sharing plan covering 100 participants. In 1998, Employer A purchases 100% of the stock of Employer B. Employer B maintains a 401(k) profit sharing plan covering 10 employees. Assume both plans are calendar year plans and that each plan meets the requirements of Code section 410(b) without aggregation. In 2001, Employer A would like its employees to be covered under a 401(k) plan. (i) If Employer A converts its profit sharing plan into a 401(k) profit sharing plan, may that plan use the "first plan year" rule of Code section 401(k)(3)(E)? Response: We believe this is okay. (ii) Would the answer be different if Employer A adopts a new 401(k) plan? Response: No. (iii) Would the answer be different if Employer A adopts Employer B’s 401(k) plan? Response: It would not be a new "K" plan, so there would not be a first-year rule available. (iv) Would any of the above answers be different if Employer A’s profit sharing plan had to be aggregated with Employer B’s 401(k) plan to satisfy the coverage requirements prior to making any changes? Response: Yes. It would not be a new plan under (i) or (iii). Comment by RLR&C ERISA attorneys: The "first plan year" or "deemed 3%" rule of Code section 401(k)(3)(E) allows sponsors of new 401(k) plans to deem a 3% actual deferral percentage ("ADP") for non-highly compensated employees ("NHCE") in new 401(k) plans that provide for prior year testing. There are two requirements that must be met to take advantage of the rule: (1) the plan must be a "new" plan (which is why the rule is unavailable in parts (iii) and (iv) above); and (2) it only applies to plans that use prior year testing method. If the plan uses the current year testing method, then it must use the actual ADP of the NHCE group for testing purposes. View all Tips © 2012 Reish Luftman Reicher & Cohen, a Professional Corporation Important notice: Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner's situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation.